Most readers would already be aware that Jumbo Interactive's (ASX:JIN) stock increased significantly by 12% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Jumbo Interactive's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Jumbo Interactive

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Jumbo Interactive is:

35% = AU$28m ÷ AU$79m (Based on the trailing twelve months to December 2019).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.35 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Jumbo Interactive's Earnings Growth And 35% ROE

To begin with, Jumbo Interactive has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 8.8% which is quite remarkable. Under the circumstances, Jumbo Interactive's considerable five year net income growth of 51% was to be expected.

As a next step, we compared Jumbo Interactive's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 10%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Jumbo Interactive fairly valued compared to other companies? These 3 valuation measures might help you decide.